A purchase price allocation (“PPA”) represents a valuation analysis that is required under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, Business Combinations when an entity acquires a controlling interest in a business. For purposes of this article, we are assuming this hypothetical transaction qualifies as a business combination and will be accounted for by applying the acquisition method. Performing an acquisition triggers additional financial and tax reporting requirements which is when a PPA comes into the picture.
So what exactly is a PPA?
The basic idea is just how it sounds. You take the purchase price or the consideration paid for the business and allocate that consideration to acquired assets and assumed liabilities. The residual amount that is left over after allocating the purchase price represents goodwill. Below, is a summary of the components of a PPA:
The purchase price is defined as the price paid by the acquirer to obtain control in the acquired company. Examples of consideration include:
Net assets refer to the total assets less the total liabilities of the acquired company. In accordance with ASC 805, in performing a PPA, all assets acquired and liabilities assumed must be reflective of fair value rather than book value. As such, there may be a need to adjust those book values to fair value. Common balance sheet items that may need to be fair valued include:
Assets acquired fall into two buckets: tangible and intangible assets.
The guidance under ASC 805 defines specific criteria to determine whether an acquired intangible asset can be recognized as a separately identifiable intangible asset in a business combination. Based on ASC 805-20-55-2 through 55-3, an intangible asset must be recognized as a separate asset from goodwill if either or both of the following criteria are met:
Intangible assets that meet either or both of the above criteria are recognized as identifiable assets and are recognized separately from goodwill and measured at fair value at the acquisition date. If the acquired intangible assets do not meet either of the above criteria, then the value of those intangible assets will be subsumed into goodwill.
Goodwill is essentially the amount paid for the acquired company in excess of the acquired company’s net assets. Goodwill is calculated as the difference between the purchase price and total fair value of assets and liabilities of the acquired company. We note under ASC 805, the fair value of an acquired assembled workforce does not represent a separately identifiable intangible asset and is subsumed in goodwill.
Calculating goodwill accurately is a critical component in the financial reporting process. Goodwill and indefinite-lived assets need to be reevaluated for impairment and when that testing occurs depends on whether the company is public or private.
A PPA needs to be completed typically after an entity has acquired a controlling interest in a business. We recommend that you discuss these events with your audit and tax professionals to ensure that you are satisfying all financial and tax reporting requirements. At Scalar, we are happy to discuss your specific situations that may require the need for a PPA.
This article is purely informative, and Scalar does not accept any responsibility for action taken based on the content of this article.
*This article addresses acquisitions that only meet the criteria of a business combination under ASC 805-10-25-1. It is beyond the scope of this article to discuss acquisitions that do not meet the criteria that are accounted for as asset acquisitions.